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Xinjiang Xinxin Mining Industry (3833.HK): Out-performer in the non-ferrous industry

Friday, October 5, 2007

5607

Xinjiang Xinxin Mining Industry(3833)

Recommendation on 5 October 2007
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Target Price	$14.350

Weekly Special - 1836 Stella International

Company Overview

Based in Xinjiang, Xinxin Mining Industry is the second largest integrated producer of nickel cathode in the PRC, approximately accounting for 3.2% of the country’s total production. The company conducts its underground mining, ore processing and smelting operation at the Kalatongke Mine with products of nickel matte and copper products; it operates its refinery plant in Fukang Refinery, producing the final products of nickel cathode and copper cathode. The major product nickel cathode accounted for 69% of total revenue in FY06, and we expect the weight of nickel cathode will further increase to above 89% and 87% in FY07 and FY08, respectively.

Reserves sustain a mining life of 30 years

The Company located and discovered 11 deposits, six of which are confirmed to have economically viable mineral resources. The Deposit Y1 is under operation, and Deposit 2 is due to commence operation in 2009. There are approximately 40,879,700tonnes of estimated ores in the 11deposits, which contains 247,408tonnes of nickel resources, and 419,337tonnes of copper. The average grade of ores is 0.61% and 1.03% for nickel and copper, respectively, above the industry average level. It is assessed that the reserves should allow a potential mining life of 30 years for the Company at the current mining rates.

Capacity expansion—the key driver of future development

The Company’s capacity of mining and ore processing stayed stably at 1000tonnes/day, capacity of refinery grew steadily from 2659tonnes/day in 2004 to 3365tonnes/year in 2006, a CAGR of 18%.

Upon the Deposit Y2 commencing to operate in FY09, we expect the capacity of mining will significantly jumped to 3000tonnes/day, the capacity of downstream products will also increase to 10,010tonnes/year by then, representing a CAGR of 72% over 2006-2009, which is the main key growth driver for the Company the future development. Considering the upside potential of nickel products price in the next few years, we forecast the total turnover can be largely leveraged, with a CAGR of 44% over 2006 to 2009.

Margins tend to improve to a more decent level

During the past 2 years, we see a gross profit margin of 50% and 59%, and net profit margin of 35% and 50% for 2005 and 2006, significantly outperformed most of its peers. We believe the decent margin is largely benefited from its vertical integrated production chain. Currently, 84.5% of nickel content and 96.7% of copper content in all the ores and metal concentrates used in the smelting operation was supplied by its own mining and smelting operation. As the result of high self-sufficient rate, the Company can also efficiently reduce the fluctuation in ore price. We believe that the margins would be further improved through the expansion projects and any upside potential of nickel price. We estimate the gross profit margin will steadily hike to 64%, 66% and 68%; net profit will also increase to 53%, 55%, and 62% in the following three years. The high margin makes the company less sensitive to the production cost, but more sensitive to the fluctuation of nickel price.

Key financial indicators outperformed the peers in 2006

Besides the significant out performance in margins, the Company achieved a decent performance in most of the financial indicators, with ROA of 28.3%, ROE of 37.76%, and net gearing ratio of –28.87%. Current ratio was maintained at a benign level of 3.62. The strong cash balance enabled the company to capitalize any expansion in the future and capture the market opportunity if nickel price hikes any further.

International nickel price may face slippage in near-term and medium-term

Before the completion of expansion project in FY09, the Company’s turnover is particularly sensitive to the nickel price. We see the nickel price provided by LME surged from the beginning of 2006, and hit the record high of $23.65/lb in May 2007. The Average price of first few months in 2007 hiked 152% yoy, which explained the significant increase in turnover over the period. However, we also witnessed the price started to slide down since May, suggesting the industry moving to the over-supply in the near-term. This is mainly due to the stainless steel producers’ purchases had not been as strong worldwide as had been projected and nickel inventories were seen to be overbuilt. Even so, the full-year 2007 average consensus is still as high as $17.26/lb, compared with the 2006 average of $6.66/lb, representing a 159% up yoy.

Looking ahead, a slippage in economic growth in the North America and Western Europe in 2008, and cutbacks in stainless steel output in China to cool an overheated metal economy, is expected to cut nickel prices by 20-25% by our estimates, with average selling price of $12.9/lb and $10.35/lb for FY08 and FY09, respectively.

Valuation

Our valuation toward Xinxin Mining is based on the peer comparison method. With no nickel mining and producing companies listed in HK market, we could only refer to the companies of non-ferrous industry. We here calculate the average consensus 07PE of 20.73X for the industry, and 21.6X for the next year.

We use the average PE for the valuation of the company; while we believe Xinxin Mining deserve a 30% premium to the average. We forecast the EPS of RMB 0.67 and RMB 0.90 for FY07 and FY08. Therefore, the 07E TP is derived at HK$14.35, and 08E TP of HK$20.09.